Peter Navarro, the head of the U.S.’s National Trade Council, has accused Germany of currency manipulation. According to the Financial Times, Navarro claimed that Germany uses a 'grossly undervalued' euro to 'exploit' its trading partners. This is a serious charge. Artificially depressing the value of a currency to benefit exporters at the expense of importers is widely regarded as trade cheating.

Unsurprisingly, Germany hit back. Rejecting Navarro’s accusation of currency manipulation, Chancellor Angela Merkel said that the Euro exchange rate was the province of the central bank, and Germany neither could nor would influence it. 'We strive to trade on the global market with competitive products in fair trade with all others,' she said.

Sadly, her comments are wide of the mark. Navarro is not saying that Germany directly influences the Euro’s exchange rate or the ECB’s monetary policy. In fact, he is not really criticizing Germany at all. He is criticizing the construction of the Eurozone.

Peter Navarro, senior economic advisor to 2016 Republican Presidential Nominee Donald Trump, center. Peter Navarro, an outspoken critic of China's trade policy, criticized Germany for 'exploiting' trade partners with a 'grossly undervalued Euro'. He said that Germany was a 'big obstacle' to viewing the Trans-Atlantic Trade and Investment Partnership as a bilateral trade deal. The White House has expressed its intention to pursue bilateral trade deals. Photographer: Andrew Harrer/Bloomberg

Since Eurozone countries share the same currency, imbalances between them cannot be absorbed by exchange rate changes. In other currency unions, such as that in the United States, federal tax and spending programs smooth out inequalities between the states: weaker states are effectively supported by transfers from stronger ones. But the Eurozone does not have a federal government, and its fiscal transfers are rudimentary at best. Weaker Eurozone countries do not receive much in the way of support from stronger ones – in fact the very idea of fiscal transfer is at present anathema to Germany’s voters.

Thus, the only mechanism for correcting trade imbalances between the member states is 'internal devaluation' – real wage cuts to force down unit labor costs and render exports more competitive. This is painful, and when a lot of countries are trying to do this all at once, it is economically destructive. The Eurozone has for some years now been locked into a low-growth, low-inflation, high-unemployment equilibrium as countries attempt to restore competitiveness by forcing down real wages.

The Eurozone’s incomplete structure explains the persistent trade imbalances between Eurozone countries. But it does not really explain Germany’s trade surplus with the US. After all, the Euro floats freely against the dollar.

Navarro ‘s argument is that the Euro’s exchange rate is dragged down by the weaker countries in the bloc. This is from a paper he wrote with Wilbur Ross last September, long before the Presidential election:

While the euro freely floats in international currency markets, this system deflates the German currency from where it would be if the German Deutschmark were still in existence. In effect, the weakness of the southern European economies in the European Monetary Union holds the euro at a lower exchange rate than the Deutschmark would have as a freestanding currency. This is a major reason why the US has a large trade in goods deficit with Germany – $75 billion in 2015 – even though German wages are relatively high.